Will spike in high LTI loans force FPC to revisit cap?

Economists are backing the Financial Policy Committee’s cap on lending at higher income multiples after the Council of Mortgage Lenders poured scorn on the policy, saying it puts pressure on mortgage affordability.

In June 2014 the FPC announced lenders had to make sure no more than 15 per cent of new lending was at income multiples of 4.5 or more.

The macro-regulator said the measure was meant to curb high future levels of household debt by stopping borrowers from taking out overly expensive mortgages with high income multiples. But CML chief economist Bob Pannell says these loans help tackle the problem of average household incomes falling behind average house prices.

Pannell says: “Mounting affordability pressures, as house prices outpace earnings growth across much of the UK, provide the most plausible explanation for the change of direction.”

The knee-jerk reaction from lenders in 2014 was to restrict this type of lending. In mid-2014 around 10 per cent of new loans were at high income multiples, but this fell to below 7 per cent the following year.

But CML figures released in late February showing lender appetite for high income multiple loans is bouncing back rapidly, showing strong underlying demand for this type of lending (see graph below).

Pannell says many borrowers struggle with mortgage affordability, and the cap is not helping.

He says: “If the impact is now showing through as upwards pressure on income multiples, then the FPC’s 15 per cent limit risks becoming a progressively harder cap over time, and we should expect to see a build-up of lending just below the 4.5 times threshold.

“Looking forward, the macro-prudential tools may help the housing market to cool. But if house price pressures persist, then the FPC may find itself subject to much closer public scrutiny as it exerts a more visible effect on the pace of housing activity and generates headwinds to the Government’s pro-home-ownership policies.”

John Charcol senior technical manager Ray Boulger says he agrees with the CML and believes the FPC and the FCA are at loggerheads with affordability policy.

He says: “The FCA introduces the Mortgage Market Review, which basically says income multiples are bad, affordability is good, so lenders should calculate the maximum on affordability. Then you had the FPC saying only a few months later that the emphasis is on income multiples.

“We are at a place now where there are too many regulators putting their finger in the pie. I absolutely agree with the CML. The regulators are doing things that impede the Government’s policy.”

But housing economists say the cap is necessary and its current level is appropriate, despite growing affordability pressures on UK homebuyers.

Capital Economics chief property economist Ed Stansfield says: “The FPC’s role is to be the party pooper and to stop the collective actions of individuals who might, in their own terms, be acting entirely responsibly and rationally, but having adverse consequences for the wider financial sector and economy.

“If at some point that rule doesn’t become restrictive, then there isn’t a lot of point in having it, or in having the FPC.”

GPS Economics director Gary Styles says there is no need to change the cap level. He says: “There is a natural limit to these things. Arguing for people to be leveraging even further on the basis that house prices have gone ever higher is not going to win you a lot of friends with the regulator, to be honest.”

Stansfield says the cap leaves lenders looking to increase mortgage affordability in the future with no choice but to extend terms.

He says: “There has been substantial movement in that direction already with mortgage terms going up past 20 to 25 years, and some even going past 30 years.”

But the Money Advice Service warns the trend towards longer mortgage periods has a sting in the tail for borrowers.

MAS money expert Andrew Johnson says: “Although this could make it more affordable for first time buyers to achieve their ambition of becoming a homeowner, it will cost them considerably more in interest repayments over the term of the mortgage.”

However, Stansfield says the FPC might take a dim view of increasing mortgage terms. “If the FPC sees that firms or borrowers are just trying to circumvent that by spreading the mortgage payments over a longer period, I’d expect them to act.”